accounting essay

The Material Price Variance Accounting Essay

Published: 23, March 2015

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The method that is used to cost the Merida costume set is Absorption Costing. Absorption costing is a method of calculating the amount of accumulated fixed cost and variable cost, which associate during the process of productions and allocate them to each of the individual items. Therefore, absorption costing also means the sum of the manufacturing costs that are absorbed in producing a product. Under a absorption costing system, the cost of a finished product will include direct material, direct labour, variable and fixed manufacturing overhead cost.

Meanwhile, marginal costing is an alternative method of costing to absorption costing. In marginal costing, only variable costs are charged as a cost of sale and a contribution is calculated.

Absorption costing method is used in this case because it stated the importance of fixed costs in a product. This method also recognized by the Inland Revenue the inventory is overvalued. Whereas, marginal costing has no apportionment for fixed costs, so mark-up has to be larger when fixing a selling price. Besides that, absorption costing is very useful in preparing financial accounts. This is due to when sales fluctuate, while the production remains constant, the fluctuation in net profit will lesser in absorption costing, this can improve the profit of the period. In contrast, absorption costing method emphasize on the total cost of both fixed cost and variable cost, therefore, it is said to be not useful in decision making, planning, and control.

On the other hand, standard costing is a technique which uses standard for costs and revenues for purposes of control through variance analysis. Variance analysis is used to observe how well does a business is performing and also explaining the differences between the actual cost and the standard cost that will incurred in a product. The main purpose of using variance analysis is to assist the management in determining the present cost and to control future cost. A high variance means the company performed differently than expected and requires additional investigation to find out the factors of the variance.

One of the advantages of using variance analysis is due to the fact that it is done on a departmental basis, because a company is usually segmented by different department or division, for instance the cost division, expense division, or cost-pool division. This makes it easier for the managers to be accoutable for any results that differs from the planned activity. Hence, variance analysis is also a fairly good way to determine the perfomance of a manager, because normal users of accounting information, or less experienced managers will merely view favorable variance as being good and adverse variance as being bad. However, one of the down sides of variance analysis is that it requires significant monitoring that will cosume a long period of time. Usually, by the time that a problem is detected, it is already too late to execute any corrective actions and these mistakes and wrong assumptions made will be very costly.

Total Variances

Material Price Variance

Material price variance refers to the differences between the actual purchase cost and the standard cost of a product. The company obtained &pound;4873,20 favourable in material price material. A favorable variance indicates that the actual price of materials purchased is less than the standard price of materials purchased.This proves that the purchasing department is sufficient to secure a cheaper source of supply for the materials. However, a favorable variance may not necessarily mean that the purchasing department is efficient in procuring materials. It could also be due to the purchase of inferior quality materials, or there is a declining price of materials in general.

Material Usage Variance

Material usage variance measures the difference between the quantity of materials used in production and the quantity that should have been used according to the standard quantity that has been formulated. When materials are used more than what is allowed by standards, an adverse variance will occured. This company shows an adverse of &pound;3920.64 as excessive usage of materials can be due to purchasing of inferior quality materials at low prices to show a favourable materials price variance. However, this problem can be solved if the company controls the quality material by selecting supplier that has good track record in terms of the price and quality of materials, and is widely chosen and recommended by other companies in the similar industry.

Labour Rate Variance

Labour rate variance measures the deviation between the amount of actual hours worked at actual rate and actual hours worked at standard rate. The labour being of a higher skill than the standard skill is the cause of an adverse in variance. Adverse will take place when there is a shortage in labour market as the company needs to pay more to hire workforce. As evidence, the company has an adverse in labour rate, which is &pound;3486.60. Nevertheless, the in charge department should assure that they have enough workforce especially during peak seasons.

Labour Efficiency Variance

Labour efficiency variances shows how efficient was the direct labour performed in making the actual products. Since the labour efficiency variance in the company is &pound;16,162.20 adverse, the company has to be more concerned. This is because more hours had taken due to less highly skilled workforce with low payment. Thus, the supervisors should put much more effort in motivating and controlling the workforce.

The variable rate variance is the difference between the actual and budgeted rates of spending on variable overhead, whereas variable efficiency variance is the difference between the actual and standard hours worked, which are then applied to the standard variable overhead rate per hour. This company has an adverse for both variable rate and variable efficiency variance, which is &pound;586.71 in total.

Fixed Overhead Expenditure Variance

The differentiation between the actual fixed overhead which has been actually incurred and the standard fixed overhead is known as fixed overhead expenditure variance. The company has an adverse of &pound;3372.50 in fixed overhead expenditure variance. The reason that lead to this result might be the increases of price for the fixed costs, such as rental, utilities and so on. This is because the company still need to pay for those expenses regardless how many products they produce.

Fixed Overhead Volume Variance

The fixed overhead volume variance gives an idea of how much more or less the actual fixed cost absorbed is when compared to the budgeted fixed overhead. There is an adverse of &pound;208.80 in fixed overhead volume variance as there might be some resources that had not been fully utilized, like the compound of the company might not been fully occupied although the rental that they paid is still the same amount.

Sales Price Variance

The sales price variance is the difference between the actual selling price and the budgeted selling price. The adverse of &pound;29,240 in sales price variance proves that the company actual price is lower than budgeted price. This is because the supply is more than the demand. Thus, the marketing department should find out some ways to attract the customers.

Sales Volume Variance

The sales volume variance is the comparison between the budgeted sales and the actual sales at standard values. There is a &pound;1545.18 adverse in sales volume variane, which means the company's sales has dropped. This result might be due to their competitors may have released a new product that are more attractive to customers. In this case, the sales department should carry out a survey to find out the customer's needs.

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